Holding checks undeposited

When an agent negotiates the purchase or lease of real estate, they typically receive a check as a good faith deposit.

The agent may hold the check undeposited until an agreed-to event occurs, such as the offer is accepted or escrow is opened, if:

the check is made payable to someone other than the broker; or

the check is made payable to the broker and coupled with:

written instructions, usually from the buyer or tenant, to hold the check undeposited until acceptance of the offer or escrow is opened; and

notification to the person to whom the offer is submitted, usually the seller or landlord, that the check for the good faith deposit is being held by the broker when the offer is submitted. [CalBRE Regs. §2832(c)]

The instructions given to the broker to hold the check undeposited until acceptance are included in the terms for receipt of the deposit contained in the offer to purchase or lease. [See first tuesday Form 150 §1]

After a buyer’s offer is accepted, the agent may continue to hold the buyer’s check for the good faith money undeposited if the seller has given the agent written instructions to continue to hold the check undeposited.

However, without instructions to further retain the check undeposited, the agent needs to deposit or deliver the funds no later than three business days after acceptance:

to the payee entitled to the funds, such as a title company or escrow;

into the broker’s trust account at a bank or other state-recognized depository; or

to an escrow depository on the broker’s endorsement, if the broker is the payee and does not want to deposit and disburse the funds from their trust account to escrow. [CalBRE Regs. §2832]

Undeposited trust funds

Separate handling rules apply to funds not deposited in a trust account. The broker is to maintain a trust fund ledger separate from the trust account identifying:

the location of any trust funds received but not deposited in the trust account; and

the date the funds were returned or forwarded, such as a check, cashier’s check, cash or promissory note that is not deposited in the broker’s trust account. [CalBRE Reg. §2831(a)(6)]

A broker is not required to keep records of checks made payable to others for services, such as escrow, credit reports and appraisal services, if the total amount of all such checks for any one transaction does not exceed $1,000. [CalBRE Regs. §2831(e)]

However, the broker is to account for the receipt and distribution of these checks on request from:

the California Bureau of Real Estate (CalBRE); or

the maker of the check exempt from entry in the trust fund ledger. [CalBRE Regs. §2831(e)]

All records of trust funds are retained by the broker for three years after the closing or cancellation of the transaction involving the trust funds. [Bus & P C §10148(a)]

Identifying the owner

A broker needs to know who owns and controls the funds held in their trust account at all times. Trust funds may only be disbursed on the authorization of the owner of the funds. Subaccount ledgers are set up to identify the owner of funds and the amount held for the owner.

However, persons other than the owner of the trust funds may have an interest in the funds. If so, their authorization is also required to withdraw the funds.

For example, consider a buyer who issues a check payable to the broker as a good faith deposit on an offer to purchase a property. The seller accepts the buyer’s offer and the broker deposits the check in their trust account as funds held on behalf of and owned by the buyer. The broker may or may not be escrowing the transaction.

The buyer is unable to obtain purchase-assist financing to fund the purchase. The buyer cancels the transaction, consistent with the loan contingency provision in the purchase agreement. However, the seller does not sign mutual cancellation instructions or other instructions to authorize the return of the buyer’s deposit. [See first tuesday Form 183]

The buyer makes an offer to purchase real estate owned by another seller, which is accepted.

The buyer makes a demand on the broker to transfer the buyer’s good faith deposit on the first transaction from the trust account to the escrow handling the second transaction. The broker refuses to withdraw the buyer’s good faith deposit from their trust account without further instructions from the seller under the purchase agreement cancelled by the buyer.

Here, the broker is acting correctly by retaining the buyer’s good faith deposit.

When a buyer’s offer, which includes receipt of a good faith deposit, is accepted by a seller and the buyer’s good faith deposit is placed in the broker’s trust fund account (or the purchase escrow), the buyer’s funds may not be withdrawn without written authorization signed by both the buyer and seller. If the funds are disbursed without mutual instructions, the broker is liable to the seller for losses due to an improper release of the funds. [Mullen v. Department of Real Estate (1988) 204 CA3d 295]

The withdrawal of trust funds

Once trust funds are deposited, they may only be withdrawn or disbursed as authorized and instructed by the owner of the funds. A third party who has an interest in the funds, such as a seller who acquires an interest in the buyer’s good faith deposit on acceptance of a purchase agreement offer, may also be necessary to authorize disbursement. [Bus & P C §10145(a)(1)]

Withdrawals or disbursements from the trust account in the name of an individual broker will be made under the signature of:

the broker named as trustee on the account;

a licensed broker or sales agent employed by the named broker under a broker-agent employment agreement [See first tuesday Form 505]; or

an unlicensed employee of the named broker, provided the unlicensed employee is bonded for the total amount of the trust funds the employee can access. [CalBRE Regs. §2834(a)]

A signer is an employee other than the broker-employer who has written authorization from the broker to withdraw or disburse funds from the trust account. This authority is either included in an addendum to the employment agreement or is provided in the agreement itself.

When the trust account is in the name of a corporate broker as trustee, withdrawals are made by:

the designated officer (DO) who qualified the corporation as a licensed broker; or

a licensed or unlicensed employee with the written authorization of the designated officer. [CalBRE Regs. §2834(b)]

However, a broker’s written delegation to others who are signers on the trust account does not relieve the individual broker or the DO of a corporate broker from liability for any loss or misuse of trust funds. [CalBRE Regs. §2834(c)]

To help prevent an improper withdrawal by an individual signer, the broker may require two signatures on trust account withdrawals. An insurance policy for the brokerage business needs to include coverage for theft by employees who have direct or indirect access to trust funds.

Improper commingling

If a broker deposits trust funds into an account used to receive and disburse personal or business funds, the broker has improperly commingled the funds. Similarly, improper commingling occurs when the broker places or leaves personal funds in a trust account. [Stillman Pond, Inc. v. Watson (1953) 115 CA2d 440]

Except to the limited extent authorized by the CalBRE, commingling is always improper.

A broker is only permitted to commingle personal or business funds with trust funds in the following two CalBRE-authorized situations:

The broker may maintain a deposit of up to $200 of their own funds in the trust account to cover bank service charges on the account; and

Fees or reimbursement for costs due the broker from the trust funds may remain in the trust account for up to 25 days before being disbursed to the broker. [CalBRE Regs. §2835]

The improper commingling of trust funds exposes the broker to a complaint and revocation or suspension of their license. [Bus & P C §10176(e)]

Monthly reconciliation

Brokers maintaining bank trust accounts are to reconcile the general ledger for the entire trust account against the separate subaccount ledger of each person and each transaction in the subaccounts. Brokers are to reconcile these accounts at least once during each calendar month deposits or withdrawals are made.

The monthly reconciliation of the bank trust account contains:

the name of the bank or thrift where the trust account is located and the account number;

the date of the reconciliation;

an identification of each subaccount in the trust account documenting the deposits, withdrawals and disbursement for each person; and

the amount of funds remaining held in trust on behalf of each person. [CalBRE Regs. §2831.2]

Commingling, conversion and restitution

Trust fund handling is regulated by a variety of penalties and consequences. A broker who misuses trust funds is subject to penalties, including:

civil liability for money wrongfully converted;

disciplinary action by the CalBRE;

income tax liability; and

criminal sanctions for embezzlement.

The penalty depends on the nature of the funds which the broker misuses.

Violations subject to CalBRE discipline

If the CalBRE Commissioner determines a broker violated trust fund accounting rules, the Commissioner may obtain an injunction against the broker to stop or prevent the violation. [Bus & P C §10081.5]

The Commissioner may also include a claim for restitution on behalf of clients injured by the broker’s misuse of trust funds. [Bus & P C §10081(b)]

If the CalBRE conducts an audit of the broker’s trust account and discovers the broker has commingled or converted more than $10,000 of trust funds, the broker’s license may be suspended pending a formal hearing.

After the hearing, a receiver may be appointed to oversee the broker’s business. The receiver is allowed to exercise any power of the broker and may file for bankruptcy on behalf of the broker. [Bus & P C §10081.5]

Commingling of trust funds is grounds for suspension or revocation of the broker’s license. [Bus & P C §10176(e)]

Civil liability

A broker who misuses trust funds needs to reimburse the owner of the funds the amount wrongfully used. [Calif. Civil Code §3281]

However, a client’s right to recover money from a broker is not limited to the amount or value of the funds the broker wrongfully converted. In addition to money losses, the client may be awarded punitive penalties based on a breach of the broker’s agency relationship with the client.

Also, when a broker uses the client’s money for their own benefit, any profits earned by the broker’s misuse belong to the client.

Punitive damages

Punitive damages, also called exemplary damages, are money awards given to a client when the broker wrongfully obtained assets, such as trust funds, from the client by fraud or with malice. [CC §3294]

Any wrongful use of trust funds is automatically considered fraudulent. The broker’s breach of their agency duty is defined by statute as constructive fraud. [CC §1573]

Thus, any broker misusing trust funds is potentially liable to the principal for punitive damages as well as reimbursement of the trust funds taken or misused. Whether punitive damages will be awarded depends on:

the severity of the broker’s misconduct; and

the agency relationship undertaken by the broker.

In instances where actual money losses are small, punitive money awards are occasionally awarded as a deterrent against future fraudulent activity.

Featured Comment

Zestimates are great conversation starters with sellers and buyers. Zillow has done more for our bottom line than NAR ever has or will. Don’t fight the current of the river, learn to run with it. Disruption is inevitable in any industry that is fragmented or inefficient. Granted, it does feel like armchair experts and platforms are plentiful in real estate these days, but when the tide rolls out we will see the value proposition of the truest professionals in this industry shine once again.